Contract fights to get uglier as budgets shrink

Jul. 16, 2012 - 09:03AM
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Alan Chvotkin is executive vice president and counsel at the Professional Services Council. (Tom Brown / Staff)

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Contractors and their lawyers are bracing for an era of bitter legal fights, as severe budget cuts force agencies to reduce, scale down and terminate contracts, perhaps as early as this year.

“It’s going to be ugly,” said John Jaeger, president of YRCI, a human resources and acquisition support company, in an interview.

The disputes won’t be over whether agencies can cancel contracts so much as how much compensation is paid to the terminated contractor, said Elizabeth Ferrell, a partner at McKenna, Long and Aldridge law firm.

“The issue is what’s the economic impact on the contractor and whether the contractor can recover additional monies as a result of that adverse action,” Ferrell added.

Contractors are most concerned about the threat of automatic budget cuts, called sequestration, that are supposed to take effect Jan. 2. Those cuts are estimated to total $109 billion annually, split evenly between defense and non-defense programs.

Sequestration cuts can be avoided only if Congress agrees to a long-term debt deal involving similarly large budget cuts. Either way, the scale of budget cuts expected will almost certainly require agencies to modify or terminate billions of dollars worth of contracts, experts said.

Experts and businesses say contract disputes will likely arise when:

 Agencies terminate contracts for convenience, which requires the agency to pay for the costs contractors have already incurred.

 Agencies modify contracts to remove some of the work required, which requires the agency to pay contractors for costs they may have incurred preparing for the larger workload.

 Agencies reduce the number and size of new contracts. Contractors who lose a competition will be more likely to challenge the decision in protest, because the chances of finding similar government business elsewhere will be diminished.

The government’s cost to terminate or scale down a contract will vary depending on the size and type of contract.

Under fixed-price contracts, for example, the government pays a set cost for a product or service. Because the contractor bears more risk, these contracts often provide sizeable payouts to companies if the contract is ended early.

Cost-reimbursement contracts, however — where the government pays the contractor for costs incurred — can be more easily adjusted because the scope of work can be changed without rewriting contract terms.

But many agencies’ first response as budgets tighten up is to award fewer contracts or to delay their awards, so as to avoid having to terminate or modify them later.

Many contractors say they are seeing this already.

Jaeger said he has bid on about 40 contracts in the last year that still have not been awarded.

Most of the work his company is doing for the government is funded through mid-2013. After that, if agencies don’t start awarding contracts he has bid on, he and other companies will have to start laying people off, he said.

“You can’t plan for being awarded work and then not getting it,” he said. “It’s like having an undiagnosed disease. It’s terrible not knowing what the outcome is going to be or what the treatment is going to be.”

As agencies award fewer contracts, the competition for those that are awarded is sure to get more fierce, contractors say. Since agencies began to slow contract spending in 2009, when spending reached $550 billion, contract disputes have jumped 18 percent, according to data from the Government Accountability Office, which decides bid protest claims.

It is unclear how much, if at all, agencies are preparing for the legal costs associated with contract disputes, said Stephan Rice, a government contracts lawyer with Crowell and Moring law firm.

A Pentagon spokesman told reporters last week in regards to sequestration that Defense Department officials “typically don’t plan against absurdities.”

“On the government side, it doesn’t seem that they’re engaging in that type of planning at this point,” Rice said.

Some experts say contractors should expect agencies to steer them to the courts if contractors wish to challenge a decision to terminate or downsize a contract. That is because many settlements won by contractors in the courts would be paid not by the agency managing the contract, but rather by the Treasury Department, which maintains a judgment fund to pay off legal settlements against the government.

Because contract disputes can be lengthy and costly, agencies are more likely to delay or reduce the size of contracts, rather than terminate them, said Dan Gordon, a former federal procurement policy chief.

“Terminating contracts in some cases can feel like you’re paying just as much as having a contract performed,” Gordon said.

Breaking a large contract into smaller contracts can also be risky, Gordon said. If an agency decides to award a contract to dig a hole for a new building instead of awarding a contract for the construction of the entire building, it may cost less, but it only leaves the agency with a hole in the ground, he said.